What is Bitcoin?

Bitcoin genesis

The ida of digital, anonymous and decentralized currency is not a new one – already in the early 90s with the development of the Internet there was an activist libertarian movement of cryptographers called “cyberpunks”, and with it a cyber-libertarian philosophy saying that privacy protection should be a priority for an open society, and cryptography and anonymous transaction system is necessary for this.

Similarities to Bitcoin can be found even in the years before the war – the oldest system of independent, local currency constantly in use is WIR (Wirtschaftsring – business circle), founded in 1934 in Switzerland by Werner Zimmermann and Paul Enza. WIR was developed because ofthe lack of physical currency and instability of the global financial system and its main task was to unite entrepreneurs and allow them to exchange services and goods through barter without using cash, which was to be replaced by the WIR currency.

Before Bitcoin, in the 90’s there were several attempts to create a virtual currency – the cryptographer David Chaum created the DigiCash system (ecash), but it was not received enthusiastically. Other similar proposals – bit gold, RPOW, b-money also did not get wide acceptance on the market.

Everything changed in November 2008, when an anonymous personality called Satoshi Nakamoto (it is still not sure if there is one specific person or group of people behind the whole project) uploaded a whitepaper on the Internet (often called a manifesto) saying about the need to create a new currency called Bitcoin: “Bitcoin: A Peer-to-Peer Electronic Cash System”

Nakamoto said that an electronic currency based entirely on the p2p system would enable the execution of online payments directly between users, bypassing institutions or financial intermediaries.

He also mentioned that there is a need to create an electronic payment system based on cryptography and there is no need to trust third parties. He said that the main problem of the current monetary system is the need to trust the central bank, which is responsible for the value of each currency, as well as commercial banks that hold our money while lending it to other people, keeping only a certain percentage in reserves.

 

Bitcoin technical aspects

BITCOIN NETWORK

The Bitcoin payment network is based on a peer-to-peer cryptographic protocol (P2P) that provides all its users with the same rights, unlike other systems where the administrator and user are involved. This means that there is no single central server responsible for Bitcoin. All users from around the world and their computers connected to the network simultaneously create and control this particular system. Despite the fact that programmers are constantly improving the Bitcoin protocol, all changes before the introduction are public and must be accepted by users to maintain full system compatibility that guarantees full transparency and motivation of both parties – developers and users to make the network as well developed.

From the perspective of an ordinary user, Bitcoin’s “system” is, in a huge simplification, nothing more than a program installed on a computer or phone containing a virtual wallet that allows sending and receiving Bitcoins. By installing this program, we create a BTC wallet, which will be described in the next part.

PUBLIC AND PRIVATE ADDRESS

The BTC portfolio consists of three numbers: public key, private key and address.
A private key is a string used to “sign” a transaction, it contains mathematical proof that the transaction comes from the owner of the wallet. This signature also guarantees that no third party can influence the transaction, which makes these transfers irreversible. The signature, by simplifying, can be compared to our e-mail password. Due to the fact that the private key allows us to make transactions, it should not be available to third parties. An example of a private key is the following string of characters:

5JHZ6Gtmry7RJ1zHscmMe1SZRMVRDR31U4zbGJanf7gKceu8Edo

Each public key is generated from the private key by multiplying elliptic curves. Afterward, using the next cryptographic methods, the proper address is created, which can be compared to the e-mail address – this is in fact our BTC address, to which we can send coins. It should be noted that the reverse operation – generating a private key from the address is practically impossible with the current technology and only using quantum computers could threaten such a state of affairs.

Our address consists of a series of 27-34 alphanumeric characters, the beginning of which starts with the number 1 or 3, and the address itself does not contain the capital letter “O”, the uppercase letter “I” as well as the lowercase letter “l” and the number “0” to prevent visual mistakes when identifying the address.

The sample address looks like this: 1LvERSxr1vCXoZt6tGeiiVmxCj7HVndc9R

You can generate it in many ways and you do not need to be connected to the Internet, because after the first transaction address  is visible in the BTC network.

The probability of generating the same address is close to 0%, because you can create 21 ^ 60 (~ 1.46 x 10 ^ 48) number of addresses. For comparison, it is estimated that the entire universe contains about 10 ^ 82 atoms, and the amount of grains of sand on Earth equals to 7.5 x 10 ^ 18.

BITCOIN WALLET

There are many ways to store and manage our Bitcoins. We distinguish among others:

1. Wallet on a computer – this is one of the safest methods of BTC storage, however, we are then fully responsible for our portfolio, because the private key is stored in an encrypted file on the disk. Loss of this file, damage or theft of the disk causes an irreversible loss of Bitcoins, therefore it is recommended to have a backup copy of one of the files that installs with the program (wallet file is called wallet.dat). Currently, we distinguish two types of wallet for a computer:

a) Bitcoin Core – this is the original BTC client. It allows complete control over your coins, and additionally serves as one of the nodes that are necessary for the proper operation of the Bitcoin network. They are used to transfer and verify transactions within the network. In addition, they store a complete copy of the block chain (register of all transactions) referred to hereinafter. Due to the fact that over time, the transaction is more and more, the original customer takes up more and more disk space. Currently, it takes over 160GB, which discourages ordinary users to use Bitcoin Core. However, nodes are a key component of the Bitcoin network and their number, as well as dispersion is extremely important. There is even a plan to put many such nodes in orbit around the Earth in small satellites to ensure the security of the network.

b) MultiBit – is a small BTC customer with all basic functions and is ideal for normal users.

2. Online Wallet – it allows us to access an account at any time from the website of a given website dealing with such portfolios, but due to the participation of third parties it is more risky. However, these websites have a number of protections and if we want to have one wallet available on each computer, they work perfectly. The most popular online wallets are coinbase.com and blockchain.info

3. Mobile Wallet – there are phone applications that provide access to funds at any time, and thanks to QR code (Quick Response) or NFC (Near Field Communication) code scanning technology, they are ideal for instant micropayments. Loss of the phone without having to back up the keys will result in the loss of Bitcoins.

4. Paper Portfolio – this is an offline storage mechanism of Bitcoins – using a physical document. It involves printing a pair of keys, this process should be performed on a computer that is not connected to the Internet, free from viruses. The private code should not be saved in any form on your computer. This is the safest, long-term method of storing more Bitcoins, but after sending Bitcoins to a different address from a paper wallet, you should no longer use it

BLOCKCHAIN

The Bitcoin network is based on a widely available, distributed database called the blockchain, in which all transactions in the form of blocks are saved and verified.

source: Bitcoin’s whitepaper

All current transactions before confirmation are collected and recorded on average every 10 minutes in a block. For the block to be approved, strict rules based on cryptography (or more precisely on the basis of the SHA-256 algorithm) must be met, which means that a proof of work must be performed, which consists in calculating a given hash at a given probability ( string of numbers and letters), which contains information about current transactions and additionally the hash of the previous block. This work is performed by miners, providing their computing power. Due to the fact that computers produce a hash based on data, Satoshi introduced a difficulty system with an additional random nonce. This is because the system will accept only the specified hash with a certain number of zeros at the beginning. The more computing power, the more difficult it is to guess the hash, and when this happens the whole system is informed and the new block is “discovered”. This enables full transaction consistency and chronology, and prevents any data editing. The difficulty of data encryption in the block is determined based on the current computing power and changed every 2016 blocks (about 2 weeks) so that generating a new block would take 10 minutes – if the blocks generated are more often the difficulty is adequately adjusted.

The difficulty can be checked, for example, here and as we can see in the chart – in the first years the difficulty was negligible, compared to what it is now. This is due to the fact that in the short history of Bitcoin extraction we can distinguish several stages, each of which was characterized by ever increasing computing power of the devices used for mining.

The first stage was to mine coins as planned and implemented in the Satoshi Nakamoto whitepaper – using processors placed in computers. It could have been done by anyone who wanted to, and because the interest in Bitcoin at the beginning was relatively low, such mining was quite effective. Currently, using a regular processor, mining is inefficient, because the power costs significantly exceed any earnings. This is due to the fact that for some time it has been discovered that the use of graphics cards is much more effective (up to 100 times more) when carrying out the proof of work which has been described earlier.

Another moment that contributed to this increase in difficulty was to start using special FPGA integrated circuits, which were programmed to calculate the algorithm built into the Bitcoin system.
The last stage that continues to this day is the use of ASICs designed from the production process, which can only be used for one purpose. They are much more effective in mining Bitcoins (which can be seen in the graph with increasing mining difficulties), and were introduced so late due to the fact that the cost of their design was very large and could be undertaken by companies with substantial capital. Currently, the Bitcoin mining market is worth millions of dollars, special facilities are being created in which Bitcoins are mined. The colloquially known large “farms” of Bitcoins can generate a monthly income of millions of dollars. At present, ASIC systems are constantly being improved (their size is reduced, and thus the power consumption is reduced). Analogies can be found in the design of ordinary processors for computers, which over the years have become smaller and more efficient. However, we will not experience next milestones in the coming years, because ASICs are the final product in the current technological progress.

CREATING COINS

Miners for their work collect Bitcoins commission, which is variable depending on the number of transactions in the network, however, this fee is not dependent on the amount we send. So the cost of sending a $ 1 BTC can be comparable to the cost of sending a few hundred BTC worth millions of dollars.

Miners also receive new coins that are created with each block. Currently, the difficulty of mining is so large that the miners combine their power in the mines (mining pool) and potential rewards share in proportion to the contribution of computing power in the mine.

The Bitcoin supply is strictly limited. At the beginning, for each newly discovered block, the reward was 50 BTC and, ultimately, every four years it is to drop by 50%. In the graph at the bottom of the page, we can see that more than 17 million Bitcoins have been mined already and the reward for the block is 12.5 BTC. By the end of 2020, 87.5% of all coins will be mined and the target value of 21 million will be reached in 2140. With the decrease of rewards, miners will keep their commissions on transactions. Although the amount of Bitcoins in circulation is limited, it will not be a billing issue, because one Bitcoin can be divided into 8 decimal places. The smallest value (0.00000001 BTC) is often called 1 satoshi.

Assuming that the value of Bitcoin will grow over time due to the declining supply, it can be considered a deflation currency – each lost wallet causes a reduction in the number of coins in circulation, and with the passage of years the market will not be flooded with new coins.

 

written by Michal Dziedzic

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